BEING A FOREIGN OFFSHORE TAX SHELTER FOR US CORPORATIONS HAS NOT HELPED PUERTO RICO, USA
Baldwin blames the disastrous economic situation of Puerto Rico to the expiration of the outrageous IRS offshore tax benefits (shelters). The truth is that it has been precisely the CFC's (Controlled Foreign Corporations) offshore tax shelter which has scammed the US Tax payer and the US Citizens of Puerto Rico. mj
by William Baldwin for FORBES
This story appears in the September 23, 2013 issue of Forbes.
This story appears in the September 23, 2013 issue of Forbes.
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| COMBATE, PR - Photo by MJ |
Would you want to lend money to a place like this? Unemployment is 14%, a third of the population is on welfare, debt ratios are worse than in Illinois and the murder rate is six times that of the U.S.
We’re talking about the Commonwealth of Puerto Rico, whose general obligation bonds cling to a Moody’s rating of Baa3, one tick above junkdom. Disinclined though you may be to buy any debt issued by the commonwealth, you may own some without realizing it.
Take a look at your tax-exempt bond fund, especially if it is of the “double tax free” variety. Morningstar counts 55 muni funds (including those that are exchange-traded or closed-end) that have 10% or more of their assets invested in Puerto Rico.
The Franklin Double Tax-Free fund has $402 million, or 63% of assets, in Puerto Rico. Two funds from the Oppenheimer family, Rochester Municipals and the Oppenheimer Limited Term New York Municipal fund, have $1 billion or more apiece on the fiscally challenged island, in each case representing about a fifth of fund assets.
New York? What’s a New York fund doing with paper from San Juan? Puerto Rican munis have the rare attribute of paying interest exempt from both the federal income tax and every state income tax. That makes the bonds suitable, at least from a tax perspective, for a single-state muni fund. This is the kind of fund, also known as a double- or triple-tax-free fund, that can pay that state’s investors a dividend free of federal, state and city tax.
Suitability for someone trying to preserve capital is another matter. The riskiest municipal bonds have a habit of taking the worst drubbing in a bear market, which is what we’ve had recently. But a fat coupon is hard to resist. The Puerto Rico bonds coming to market in September are expected to yield 7%. That’s double the yield on Vanguard’s nationally diversified long-term muni fund.
Most national muni funds resist the temptation to prop up yields with large doses of Puerto Rico debt. The iShares S&P National AMT-free Muni Bond ETF (MUB) has, among its larger positions, a mere 0.3% position in one of the commonwealth’s bonds. But a Morningstar list of funds with significant stakes includes some closed-ends from BlackRock BLK +0.88%, including its Muni Holdings NY Quality (MHN). Several funds from Franklin Templeton (BEN) make an appearance.
Puerto Rico’s small population (3.7 million and dwindling) shoulders a giant debt load: $70 billion in government borrowing plus $33 billion of pension underfunding. Only a fourth of the residents have jobs, and 27% of those jobs are government jobs. Private-sector employment is 647,000. That happens to be half the number of people receiving food stamps.
The island is getting to look like a Detroit with beaches. The bankrupt city and the troubled commonwealth have the same problem: It’s too easy to leave. Detroit’s middle class departed for the suburbs. Puerto Rico’s workers are boarding airplanes to New York and Miami. As U.S. citizens, they don’t need green cards.
Prospects for job growth are dim. In 2009 Governor Luis Fortu?o came into office with a Reaganesque plan to promote business, cut taxes and shrink government. He didn’t last long. Voters tossed him out last fall in favor of a traditional spender.
Any business courageous enough to set up shop in Puerto Rico faces a headwind in the form of costly electricity from the government-run, oil-fired utility. The utility, itself a chronic borrower, gropes for positive news in a recent prospectus by citing its “energy theft reduction initiatives.”
For a while there was a burst of manufacturing employment as U.S. pharmaceutical companies took advantage of a law that enabled them to lighten their federal tax burden in return for making pills in Puerto Rico. That congressionally bestowed tax holiday ended in 2006.
In part because of the expiration of the tax benefit, says Moody’s analyst Lisa Heller, Puerto Rico sank into recession a year ahead of the rest of the U.S., and its GDP is still falling.
Moody’s analysis includes a calculation in which unfunded pension liabilities are added to outstanding tax-supported bonds (as opposed to bonds being repaid from utility fees and the like). For Illinois, famous for promising lavish pensions without setting money aside, that total fiscal burden comes to three years of tax revenue. For Puerto Rico it’s five years of revenue.
Puerto Rican bonds have their defenders. Troy Willis, a portfolio manager for Oppenheimer’s tax-exempt funds, notes that the government is tackling its pension problem by moving new hires into a 401(k)-style plan. As for the scary debt total, he says, you have to cut Puerto Rico some slack because it does borrowing that on the mainland would be done at the federal or city level.
You can make money in risky bonds, so long as they don’t default. Over the past decade Rochester Muni has delivered a performance that puts it ahead of 99% of its peers. At the moment, though, risk is overshadowing reward. So far this year Rochester Muni is down 10.9%, versus a loss of 4.9% for a Barclays BCS +2.65% index of munis. In March Standard & Poor’s lowered its rating on Puerto Rico to BBB?. Moody’s attaches to its comparably low view of the debt a “negative outlook.”
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